Key Bank of England Inflation Yardstick Offers Little Comfort: DMP Latest

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A key Bank of England yardstick used to ascertain domestic inflationary pressures confirms UK wage inflation remains resolutely sticky, casting doubts on the Bank's ability to bring inflation back to 2.0% in the medium term.

The Bank's Decision Maker Panel survey of businesses revealed year-ahead wage growth expectations slightly increased to 5.3% on the month in June, up from 5.2% in May.

High wages meant that firms reported annual unit cost growth remained at 9.4% in June and expectations for year-ahead unit cost growth increased by 0.5 percentage points relative to May.

However, the three-month averages were little changed.

This suggests businesses continue to face elevated cost pressures that the Bank of England fears will contribute to ongoing above-target inflation.

The Bank raised interest rates by 50 basis points in June and said the move recognised a risk inflationary trends were becoming entrenched in the UK economy as firms raised prices and workers required higher pay.

There was some good news, however, in that realised output price inflation declined to 6.9% in June, down from 7.6% in May.

"There are indications from the survey that firms’ price and wage growth expectations are moderating, but they remain high relative to historical averages," says Hann-Ju Ho, an economist at Lloyds Bank.

The three-month moving average also fell from 7.6% to 7.3%. Note that the DMP covers own prices from firms across the whole economy, not just consumer-facing firms.

Businesses meanwhile expect output price inflation to fall over the next year as the year-ahead output price inflation was expected to be 5.3% in the three months to June, down from 5.4% in the three months to May.

One year ahead CPI inflation expectations decreased to 5.7% in June, down from 5.9% in May.

This would make a mockery of the Bank of England's ever-optimistic forecasts that inflation will fall back to 2.0% over the forecast horizon.

Indeed, three-year ahead CPI inflation expectations slightly increased to 3.7% in June, up 0.2 percentage points relative to May.

Current CPI perceptions of firms were 8.9% (down from 9.8% in May) which is close to the 8.7% actual CPI inflation rate during the survey window.

In all, these findings are consistent with further interest rate hikes at the Bank of England, with market pricing showing investors expect Bank Rate to peak at 6.25% before the cycle is done.

"Second-round effects from higher energy prices have broadened, with strong private-sector pay growth and rising inflation in less energy-intensive components of core inflation. These second-round effects are likely to be more persistent than the direct and indirect effects from energy prices, unless restrained by tight monetary policy," says Michael Saunders, former Bank of England MPC member and Senior Economic Advisor to Oxford Economics.